Cash Flow Real Estate Investing: How CAPT Can Make You Rich
Why Real Estate Investing for Cash Flow is Your Safest Bet
I’ve been accused of using too many acronyms on more than one occasion. And more often than not, it’s a fair accusation! You can blame it on a military father or too much time in the Big 5 Consulting ranks, but I could probably have an entire conversation in acronyms. Even if you aren’t talking to yours honestly, there are so many acronyms flying around in real estate investing that it’s not easy to know which ones are important. Let’s discuss a wonderfully memorable and meaningful acronym that can make you rich: CAPT.
What Does CAPT Stand For?
CAPT denotes the different kinds of benefits that you can receive from real estate.
- C stands for Cash Flow
- A is for Application
- P stands for Principal Reduction
- T is for Tax Benefits
Owning and operating investment real estate can help you and your portfolio realize some, if not all, of these benefits.
What is Cash Flow?
Cash flow is the benefit you receive every month renting real estate. Cash Flow is money that comes in every month. Assuming that your monthly cash flow is more significant than your monthly expenses and debt service, the property will be cash flow positive. As a result, cash-flow real estate investing is the safest way to ensure a return on your investment.
What is Appreciation?
Appreciation is the benefit you receive when you sell your investment property for more than what you paid (plus any improvements or expenses.) If you sold a home anytime before 2007, you no doubt experienced the benefit of Appreciation. It is often where you will make some of the most considerable sums of money in real estate. That said, Appreciation is also CAPT’s most volatile (i.e., risky and prone to market fluctuations) aspect. Many who have sold a home in the last year can attest to this first-hand. However, several markets have bucked the trend and are doing quite well. We have had some success in Texas, Oklahoma, and Kentucky – to name a few markets where we have recently had some excellent Appreciation benefits.
What is Principal Reduction?
Principal Reduction is the tried and true model of your tenant paying for your mortgage and principal payment every month. In essence, your tenant buys your property for you over time. Principal Reduction is more a function of loan term than anything else. You can accelerate Principal Reduction in your projects if you focus on loan assumptions of commercial properties farther along in their amortization schedule. The only drawback to principal paydown is that you only recognize the benefit at liquidity events (i.e., sale, refinance, etc.)
What are the Tax Benefits of Owning Investment Real Estate?
The tax benefits of owning investment real estate are nothing less than outstanding. Imagine owning a dividend stock with very little volatility that pays a 15% tax-free dividend. Real estate as an asset class gets all the standard deductions of any investment business with the added benefit of a paper loss called depreciation. The net benefit is that depreciation as a paper loss can often offset entirely the cash flow from your investment property. In certain situations, it can offset even more than your current cash flow, and you can create a “depreciation bank” or use the excess depreciation to offset any other income.
Each investment will receive some benefit from each of the four areas, but the blend will differ depending on the type of investment. For example, you won’t usually find high cash flow on a percentage return basis in the same investment as high appreciation potential.
Let’s compare California and Kentucky to explore this concept further. Getting a cash-flow-positive rental in San Francisco is almost impossible unless you put 50% down (even then, it’s marginal). In many parts of Kentucky, you can find a great property where you receive 15% to 20% cash on cash returns. California will experience higher appreciation (>10%) and devaluation (>30%), while Kentucky will motor along at a steady appreciation rate of 2% to 4% per year.
By analyzing your investment projects through the CAPT lens, you’ll better explore the benefits and the blend within your real estate portfolio. If you have a lot of cash-flow property but not enough depreciation, you could consider obtaining commercial properties that spin-off more depreciation because of their larger values. This is a great way to offset your taxable cash flow.
If you’re receiving an ROE (Return on Equity) of less than 10% in your real estate portfolio, what could you do to free up some principal to increase your rate of return? If you have a blend of properties across several asset classes, how do you know if you’re getting the best return on that portfolio? Where do you want to focus if you’re just starting Real Estate investing? What type of benefit could help you most now?